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CFA Level 1 Practice Questions

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This document contains a collated list of the 100 questions we have put on various forums over the last 4

months or so. The document also contains solutions, which should help you revise major concepts well.

All the best!!!

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CFA Level 1 question 1

Mark a student in university needs to pay tuition fees of USD 1100 per year for next three years with the

first installment due on exactly one year from now. If Mark can earn 7% by investing in the bank, the

minimum amount of money that Mark need to invest today to meet his total university fees requirement is

closest to

a) USD 2,887

b) USD 3,084

c) USD 2,982

Answer A: 1100/ (1+7%)^1+ 1100/(1+7%)^2+ 1100/(1+7%)^3 = USD 2886.7


Robert is investing USD 2,500 in a yearly Recurring Deposit (RD) scheme from last year. If the bank pays an

interest of 8% p.a and his 2nd installment is due today then the amount of money he will get at the end of

the RD is closest to

a) $ 15,568

b) $ 15,840

c) $ 14,667

Answer B: 2500*(1+8%)^5 + 2500*(1+8%)^4+2500*(1+8%)^3+2500*(1+8%)^2+2500*(1+8%)^1 = USD

15,839.8


Rahul is planning to go for an European tour. The cost of the tour if paid immediately is USD 4,500.

Alternatively the tour operator provides an option to pay the tour cost in installments of USD.1200 per year

for 4 years with the 1st due payable immediately. The rate of interest at which Rahul will be indifferent

between choosing immediate payment and tour operator’s installment scheme is closest to

a) 0.85%

b) 2.63%

c) 4.48%

Answer C: 4,500 = 1200*(1+r)^0 +1200*(1+r)^1 +1200*(1+r)^2 +1200*(1+r)^3. Solve for ‘r’ in the equation.

R= 4.48%


T &L Ltd is evaluating an investment in an infrastructure project which would require them to invest USD

45,000 and USD 25,000 at the beginning of year 1 and year 2 respectively. From year 3 through 5 the

project is expected to give cash inflow of USD 30,500 at the end of the year for each of the three years. If

T&L’s cost of capital is 8% then based on Net Present Value concept for evaluating a project T&L should

a) Accept this project as the NPV is USD 4,631





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b) Accept this project as the NPV is USD 4,289

c) Reject the project as NPV is USD (-760)

Answer C: NPV of cash outflows = 45000/(1+8%)^0 + 25,000/(1+8%)^1 = -68,148. NPV cash inflows = 30,500

/(1+8%)^3+ 30,500 /(1+8%)^4 +30,500 /(1+8%)^5 = 67,388

NPV = -68,148+67,388 = -760.07


Professional Ltd is evaluating 2 mutually exclusive projects. Project A would require an investment of USD

5000 at the beginning of year 1 and will give cash inflow of USD 3000 in the beginning of each of year 2 and

year 3. Project B would require an investment of USD 10000 at the beginning of year 1 and will give cash

inflow of USD 5800 at the beginning of year 2 and USD 6000 at the beginning of year 3. If Professional Ltd’s

Cost of capital is 9% then the company should choose

a) Project A as it has an IRR 13.07% which is higher than project B’s IRR

b) Project B as it has an NPV USD 371 which is higher than project A’s NPV of USD 277

c) Project B as it has an NPV USD 340 which is higher than project A’s NPV of USD 254

Answer B: Project A’s NPV is USD 277 and Project B’s NPV is USD 371. (note that the cash flows are the

beginning of the year). In case of conflict between NPV and IRR, project with higher NPV should be given

preference.


Mask Ltd is investing in a project which would require an investment of USD 100,000 immediately. The

project will provide a cashflow of USD 42,000 for the next three years starting from the end of current year.

The cost of capital for Mask Ltd is 7%. The Discounted Payback period for this project is close to

a) 2.70 years

b) 2 .67 years

c) 2 .91 years

Answer A: -100,000 * (1+7%)^0 + 42,000*(1+7%)^1+ 42,000*(1+7%)^2 = -24063. At the end 2nd year 24,063

need to be recovered. For the full year USD 34,285 on PV basis will be recovered. 24,063/34285 leaves us

with 0.7 years. So discounted payback period = 2 years + 0.7 years


Bluebay Ltd reported the following in their latest annual report. Value of equity – USD 25.3 million, Value of

Debt – USD 9.82 million. The current market cap of the company is USD 38.6 million and the market value

of debt is USD – 9.82 million. The company’s cost of equity is 12% and the post tax cost of debt is 7.5%. The

company’s effective tax rate is 40%. Bluebay’s weighted average cost of capital is close to

a) 10.74%

b) 11.09%

c) 10.48%





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Answer B – 11.09%: Please note the given cost of debt is post tax and hence no tax shield adjustment is

required for cost of debt. For calculating WACC market value should be used.


Farm Ltd has USD 10 mn debt outstanding at a cost of 6%. The company plans to issue new bonds worth

USD 8 mn at a cost of 7% which is likely to be subscribed at par. The company’s market value of equity is

USD 24 mn and book value of equity is USD 14 mn. Farm’s cost of equity is 12%. If the company’s effective

tax rate is 30% then the weighted average cost of capital of the company post the new debt issue would be

close to

a) 9.86%

b) 9.78%

c) 8.96%

Answer C: Remember for calculating WACC one need to use marginal cost of the respective capital. Hence

pre tax cost of debt is 7%. Post tax cost of debt is 4.9%. Weight debt post new issue is 42.86%. Hence WACC

= 42.86%*4.9% + 57.14% * 12% = 8.96%


Brigade Ltd currently has total asset size of USD 110 mn. The company’s book value of equity is USD 65 mn

while the market cap is USD 97 mn. The cost of equity of brigade is 11.2%. The debt of the company is

issued as bonds with coupon of 4.5% and has 5 years remaining for maturity. The bonds which pay coupons

semi-annually are quoting at a yield of 3.9% The Company’s marginal tax rate is 35%. The Weighted

Average Cost of Capital of Brigade Ltd would be close to

a) 8.40%

b) 8.45%

c) 8.84%

Answer A: Finding market value of debt: Face value of debt = BV of assets – BV of equities; 110- 65= 45;

Coupon = 4.5%, yield 3.9%. Semi-annual coupon is known. Market Value of debt = 46.22

Market value of debt = $46.22 mn. Market value of equity = $97 mn. Cost of debt = 3.9%, post tax cost of

debt = 3.9% * (1-35%)= 2.54%. WACC =8.40%.


NNC Ltd has 100 mn preferred shares outstanding. The cumulative market value of these preference shares

is USD 980 mn. Each preference share pays a dividend of USD 0.51. The effective tax rate of the company is

30% and the book value of these shares is USD 800 mn. The cost of NNC’s preferred equity is close to

a) 3.64%

b) 5.20%





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c) 6.38%

Answer B: Price of Pref share = 980/100 =9.8. Cost of pref share = 0.51/9.8 = 5.20%. Remember Pref share

do not attract tax shield.

CFA Level 1 Question 11

DIFC Ltd paid a dividend of $1.3 last year and the dividends are expected to grow at a rate of 5%

perpetually. The shares of DIFC are trading at a price of $ 38.5. The cost of capital for DIFC using dividend

discount model is closest to

a) 8.38%

b) 3.55%

c) 8.55%

Answer C; Remember r= D1/P +g (it is not D0 – Do is the last dividend). D1 = D0*(1+g)= $1.365. r=

1.365/38.5+5%=8.55%


Marc Ltd currently sells 45,000 units of its products. The Price per unit is $7.5 and Total Fixed cost is

$101,250. The current operating income is $56,250. The Degree of Operating Leverage for the company is

close to

a) 2.3

b) 2.8

c) 2.6

Answer B: Sales – Fixed cost – Variable cost = operating income; variable cost = 45000*7.5 – 101250 –

56250 = 180,000; VC per unit = 180,000/ 45000 = 4

DOL = Units *(Price – Variable cost) / [Units *(Price – Variable cost) – Fixed cost]

45000* (7.5-4) / { 45000 * (7.5-4)-101,250) = 2.8


JPM Ltd deposited a total amount of EUR 75,235 in its bank account in the month of January 2013. The

average daily float for the company is EUR 3,955. Based on this which of the below conclusion can be

arrived at

a) On an average it takes 1.58 days for the checks deposited by JPM to be collected

b) The company’s float factor is 0.61

c) On an average it takes 1.63 days for the checks deposited by JPM to be collected





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Answer: C; Note it is January 2013, so the month has 31 days. Average daily deposit = 75235/ 31 = EUR

2,427. Float factor = Average daily float/ Average daily deposit; 3955/2427=1.63; Indicating it takes 1.67

days on average to collect checks.


Raligam Ltd is looking for a short term financing of $75,000 for 1 month. They are evaluating the following

options

i) Line of credit (LoC) that costs 7.2% and a commitment of fee of 0.4%.

ii) Banker’s acceptance (BA) of 7.6%, all inclusive.

Raligam should choose

a) LoC as the cost is 7.6% which lower than BA’s cost of 7.65%

b) Either, as both costs 7.6%

c) Either, as both costs 7.65%

Answer A: LoC’s cost = [75000*(7.2%+0.4%)/12]/ 75000 = 7.6%; Cost of BA = [75000*7.6%/12] /. [75000-

(75000*7.6%/12)] = 7.65%


Below are the current assets and current liabilities details of Bram Ltd. The acid test ratio of the company is

close to

Cash ; 34

Inventory; 55

Short term investments; 32

Accounts Payables; 42

Accounts Receivables; 38

Short Term Borrowings; 21

a) 2.52

b) 1.83

c) 1.65

Answer C: ( Cash + Short term investments + Accounts Receivables ) / (Account payables + Short term

borrowings)

(34+32+38) / (21+42) = 1.65





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Selected items from TAMSAC Ltd are presented below. The company plans to buyback 1.8 mn shares and

they are proposing to fund this buyback through borrowing. The new EPS of TAMSAC after the buyback will

be close to

Shares Outstanding (mn); 20

Price of the share (USD); 3.74

EBT (USD mn); 8.46

EPS (USD); 0.283

Marginal Borrowing Rate; 5.70%

a) USD 0.297

b) USD 0.440

c) USD 0.311

Answer A: PAT (EPS * Shares); 5.67

Tax (EBT-PAT); 2.79

Tax rate(tax/EBT); 0.33

Money required to buy 1.8 mn shares (1.8*3.74 mn); 6.732

Interest on Borrowed money (6.7* 5.7%); 0.384

New EBT (old EBIT - incremental interest); 8.07

New PAT (New EBP * (1-Tax rate)); 5.41

New share OS (20-1.8); 18.2

New EPS (New PAT/ New shares OS); 0.297


Cook an analyst is working on estimating asset beta for BigBet Ltd. He calculated the Beta of the equity

from Stock price and relevant index return as 1.32. He also collected the below information from the latest

financials of the company (values ate in USD mn). The Asset Beta of BigBet is closest to

Net Worth: 750

Total Debt: 575





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EBIT: 416.17

EBT: 373.04

Net Profit: 242.48

a) 1.98

b) 0.97

c) 0.88

Answer C: Beta(Asset) = Beta (Equity) * [ 1/ {1+ D/E* (1-t)}]

Tax paid = EBT – PAT = 130.57; Tax rate = 130.57/373.04 = 35%

D/E = 575/750 =0.77; [ 1/ {1+(0.77*(1-35%))}] * 1.32 = 0.88

CFA Level 1 Practice Question 18

Which of the below corporate action will affect the capital structure of the company

a) Cash Dividend

b) Stock Dividend

c) Stock Split

Ans A; Stock dividend and stock split do not involve cash and hence will not affect capital structure. Post

stock dividend and stock split the Net worth and Debt in Dollar terms will remain the same and hence the

capital structure

will not change. In case of cash dividend Net worth will decrease resulting in increase of Debt – Equity ratio


Rave Ltd has 10 million shares outstanding and they are planning to buyback 1 million shares using the cash

in books. The shares of the company are presently trading at a Price to Book Value multiple of 1.7X. Post

the buyback Rave Ltd’s Book Value Per Share (BVPS) will

a) Increase

b) Decrease

c) Not Change

Ans B: For example Let us take Book Value of Rave Ltd’s equity is $100 mn. BVPS = 100/10 =10. Current

price at P/B of 1.7X = 1.7*10 =$17. IF Rave buy’s 1 mn shares are at $17/share, the networth post buy back

=$83 mn. Shares outstanding post buyback = 10- 1 = 9mn. BVPS post buy back = 83/9 = $9.2 which is less

than BVPS of $10 before buy back


Tigeress Ltd has below operating details. The Degree of Total Leverage for the company is close to





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Unit Produced – 10,000

Price per unit - $10

Variable cost per unit - $4

Total Fixed cost - $37,500

Total Borrowing – $75,000

Cost of Borrowing – 5.2%

a) Data Insufficient

b) 2.67

c) 3.20

Ans C: DTL = DOL * DFL or

Q * (P-V)/ [ Q (P-V)-F-C] = 10,000 * (10-4)/ [ 10000*10-4)-37500-75000*5%] = 3.2


Which of the below is NOT an essential characteristic of an effective board structure

a) Majority of the board members should be independent

b) Directors should have complete access to the company’s financials

c) Director’s should have right to hire external consultants on the advice of Management

Ans C: Director’s should have right to independently hire consultants without Management’s intervention.


Which of the below statement is MOST accurate about stock Beta as defined by CAPM model

a) Beta is a measure of sensitivity of the stock’s price to the movement of the market

b) Beta accounts only for diversifiable risk

c) Beta is given by ratio of variance of the stock to variance of the market

Ans A: Beta is given by the ratio of covariance between stock and market to variance of the market. Beta

accounts for only risk that cannot be diversified.


In case of stock split, which of the below type of index results in change in weight of ALL the constituent

securities of an index

a) Price weighted index

b) Unweighted index

c) Market Cap weighted index





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Ans A: Unweighted index and market cap weighted index are not influenced by the price of the security.

Only Price weighted index are influenced. For example in case of 1:2 split the weight of the split security

will approximately fall by 50%. The remaining 50% of the erstwhile weight of this security will be distributed

across all other remaining constituents, which would result in change in weight for all the securities.


Mannar Exports Ltd reported a Networth of USD 72.35 mn on 31-Dec-2011. On 31-Dec-2012 the company’s

networth stood at USD 79.95 mn. Looking in to the cashflow statement of the company an analyst noticed

that the company paid a total dividend of USD 3.26 mn in 2012 and there were no issue or buyback of

equity during the year. Mannar Export’s Dividend payout ratio for the year 2012 is closest to

a) 4.50%

b) 4.01%

c) 30.02%

Answer C: Net profit in 2012 = Increase in networth + Dividends; = 79.95-72.35+3.26 =10.86;

Dividends pay-out ratio = dividend / Net profit = 3.26/ 10.86 = 30.02%


Below are the details of a sector index. The closing value of market cap weighted index on the previous day

is 1457. The value of index at the end of today’s session will be closest to

a) 1475.24

b) 1470.85

c) 1436.25

Stock No of Shares (mn) Previous closing price Today's closing price

ITC 8,341 341 359

HUL 2,001 681 633

Colgate Palmolive 134 1,443 1414

Dabur 1,712 174 171

Answer B: Market cap to be determined by previous days price. For each stock market cap/ Total Market

cap of index * Stock return will give the return contribution to the index. Sum of these contributions is total

retun of index for the day which is 0.95%. Closing value = 1457 *(1+0.95%) = 1470.85


Rash Ltd reported an EPS of $2.5 for the year 2012. The company’s current market cap is $340 mn and Price

/ share is $17. The company’s net worth at the end of 2012 is $200 mn and the company paid no dividends

for the year. The Return of equity of the company is closest to

a) 28.57%

b) 25.00%





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c) 14.71%

Answer A: Shares OS = 340/17 = 20 mn. Current networth =200 mn; current year profit = 2.5 * 20 (shares

OS) = 50. Last year book value = 200-50 – 0 (dividend) = 150. Average book value = 175. RoE= profit/ Avg

Book value = 50/175= 28.57%


Sailor Ltd has issued preference share issued at face value of $10. These shares attract a dividend of 7%.

Presently these shares are trading at $9.23. The cost of these preference shares is closest to

a) 7.58%

b) 7.00%

c) 6.46%

Answer A: Price of preference share with no dividend growth = Dividend / Cost of pref capital. 9.23 = 0.7/r;

r = 0.7/ 9.23 = 7.58%. Cost of capital need to be calculated on Marginal cost of capital, not issue price.


Schindler Ltd issued common shares with face value of $10. Presently the share are trading at $25. The

company’s paid a 20% dividend on the face value of the shares last year. An analyst estimates the cost of

equity for Schindler is 14.2%. The estimated growth of Schindler according to Dividend Discount model is

close to

a) 4.83%

b) 6.20%

c) 5.74%

Answer C: DDM Price = D*(1+g)/ (r-g); Last year dividend = 10*20% =$2; so, fo DDM 25 = 2*(1+g)/ (14.2% -

g); 2/25 *(1+g) = 14.2% -g; ( 8% + 8%*g) = 14.2% -g ; g+.08g = 14.2% - 8%; 1.08g = 6.2%; g =5.74%


In Financial marketing Parlance which of the below statement correctly describes the way in which

practitioners classify the ‘Money Market’ and ‘Capital Market’

a) Money Market is for trading debt instruments and Capital market is for trading equity instruments

b) Money Market is for short term fund raising and Capital Market is for long term fund raising

c) Money Market is used for raising fresh capital and capital market is used for trading existing issues

Answer B: refer Page 15 in curriculum Book 5.


Which of the below factors is LEAST likely to contribute to increasing the efficiency of the markets. The

National stock exchange of India





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a) Decreased the exposure limit for individuals on USD-INR currency position to USD 25,000 from USD

50,000

b) Decreased the maximum brokerage charged on trades from 2.5% to 2.0%

c) Increased the number of securities traded in Futures and Options segment from 250 to 550

Answer A: decreasing position limits will lead to arbitrage opportunities


When a person says ‘I am long in a put option’ then he implies

a) He has sold the right to sell a stock at a specific price

b) He has bought the right to sell a stock at a specific price

c) He has bought the right to buy a stock at a specific price

Answer B: Long in an option means buying an option. Put option implies right to sell. The person has

bought the right to sell.


Which of the below option correctly lists the following securities in ascending order of their respective risks

i) Ordinary Equity shares

ii) Non convertible bonds

iii) Preference shares

iv) Optionally convertible bonds

v) Callable bonds

a) V,IV, II, III,I

b) V,II,IV,III,I

c) IV,II,V,II,I

Answer C: The optionally convertible bond gives option of converting the bond in to shares to the buyer

and hence if share price increases he can convert else he can choose to redeem the bond. This makes

option IV less risky than ordinary bonds. The callable bond gives issuer the right to call the bond which

makes it more risky than ordinary bond. A preference share is more risky than bonds and ordinary share

possesses highest risk in the list.


Which of the below indices has the highest chance of suffering from representation bias

a) Hedge fund indices

b) Bond indices

c) Global Equity Indices

Answer A: Hedge funds report their performance only to specific index managers and hence the underlying

representation in each index will be biased.





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Which of the below type of industry classification would MOST likely suffers from the disadvantage of

possibility of frequent change in grouping

a) Product based classification

b) Business cycle sensitivity based classification

c) Statistical classification

Answer C: Statistical classification is done based on correlation of share price movement in the past. Hence

it may change frequently. The other classifications are unlikely to change frequently


Which of the below criteria is MOST likely to make Raze ltd incomparable with Braz Ltd for the purpose of

Peer Valuation

a) Both Raze Ltd and Braz Ltd produce and sell Steel and Copper.

b) Raze Ltd derives 30% of its revenue from steel and the remaining from Copper while Braz limited

derives 40% of its revenue from copper and the rest from Steel.

c) Raze Ltd does retail sales of the metals through stores owned by the parent company and Braz ltd

does retails sales through a wholly owned subsidiary

Answer: B. The proportion of the revenues is different which makes them incomparable. The sale through

subsidiary does not matter as on consolidated basis both companies will be same (all other things

remaining the same)


Ram bought one share of Sokia Ltd at Rs.2900 through leveraged buying. The initial margin for the position

is 30% and Maintenance margin is 25%. The percentage price drop in sokia’s share price which will result in

margin call for Ram is closest to

a) 5.00%

b) 6.67%

c) 7.82%

Answer B: Margin call price = (Purchase price – Initial Margin)/ (1-Mainteneance margin)

Price = 2900

Initial margin = 2900*30% = 870

M.Margin = 25%

Margin call price = (2900- 870) / (1-25%) = 2707.

Price drop % = 2707/ 2900 -1 = 6.67%





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Which of the below statements about Swaps is MOST likely incorrect. Swaps

a) Are equivalent of series of forward contracts entered at the same time and expire at various times

in the future.

b) May or may not involve a clearing house for settlement

c) Are equivalent to buying a put option and selling a call option.

Answer C: Forward contract is equivalent to writing a put and longing a call. The statement also does not

mention anything about series of options. Also only series of forward contract make a swap.


Which of the below is NOT a difficulty in constructing a fixed income index

a) The constituent securities cease to exist after maturity.

b) The fixed income market is a dealer driven market

c) The values of securities will be selectively disclosed to the index managers.

Answer: C. The values of the constituents will be disclosed to index managers in case of hedge funds. Fixed

income securities are listed and hence all the data are available for index managers.


Taco Ltd is electing 3 directors in the Annual general meeting scheduled next week. David holds 1000

shares of Taco Ltd. If Taco follows cumulative system of voting for electing its directors then number of

votes that David can cast in the election is

a) 1000

b) 3000

c) 5000

Answer B: Under Cumulative voting number of votes that a share holder can cast = Number of directors to

be elected * No of shares. 1000* 3 = 3000


A Company that is in the business of purchasing electric power and distributing it to the households is

MOST likely to be classified as which of the below sectors

a) Consumer Staples

b) Energy

c) Utilities

Answer C: Consumer staples are items which are essential for day to day living and cant be postponed like

food, beverages etc . Energy are items which used to generate energy which in turn is used in other process

ex, crude oil exploration, coal mining etc.





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Raghav an analyst is trying to find the intrinsic value of a company using discounted cash flow method. In

the process he did most of the things right except for the fact that he overestimated the cost of equity. He

will most likely ------------------------- the intrinsic value

a) Overestimate

b) Under estimate

c) Correctly estimate

Answer B: Underestimate. Over estimating cost of equity would lead to discounting of cash flows by a

bigger denominator. This is turn would lead to estimation of intrinsic value that is lower than the correct

value.


Short term capital management Ltd (STML) declared a dividend per share of $4.2 last year. Their dividends

are expected to grow at 5% while the cost of equity for the company is estimated at 9.5%. STML’s book

value of asset is $ 622 mn and market value of these assets is estimated at $ 710 mn. The company has

total debt outstanding $ 320 mn and shares outstanding of 10 mn. The minimum intrinsic value per share

that the company should comment will be close to

a) $ 98.00

b) $ 30.20

c) $ 39.00

Answer C: The minimum price that a share should comment will be driven by asset based valuation. Asset

based valuation of equity = (Market value of equity – Debt) / Shares outstanding. Price = (710-320)/10 = 39


Raj invested $ 1500 in a two year bank Fixed Deposit. At the end of 2 years he received $ 1752. The FD’s

quoted interest rates are compounded quarterly. The quoted interest rate of bank would be close to

a) 8.074%

b) 7.84%

c) 8.40%

Answer B: Quoted interest rate =

[ (Final value/ Starting value)^ {1/ (no of years* Compounding frequency)} ] -1

= { (1752/ 1500) ^ (1/ [@*4])} -1 = 7.84%


A better measure to evaluate a fund manager’s performance is

a) Holding period return





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b) Money weighted return

c) Time weighted return

Answer C: Time weighted return eliminates the change in return due to timing of additional investment and

partial withdrawal during the holding period, hence its is considered as better measure to evaluate fund

manager’s performance (Book 1:Page 302)


The mean of returns of German stock markets is 9.7% and the standard deviation is 36.4%. According to

Chebyshev’s inequality the proportion of returns that will be in the range from (-44.9%) to + 64.30% will be

closest to

a) 86.64%

b) 55.56%

c) 66.67%

Answer B: Chebyshev’s inequality states that the proportions of returns that lie between Mean +/- ‘k’

standard deviations will be given by 1 – [ 1/ (1/ k^2) ] ; 9.7% - (-44.9%) = 54.6% and 64.3% - 9.7% = 54.6%. k

= 54.6% / 36.4% = 1.5 ; appyling this in the above formula would leave us with a value of 55.56%


A sample of return that has more frequent extreme large surprises is MOST likely to be

a) Mesokurtic

b) Platykurtic

c) Leptokurtic

Answer:C. When there are frequent surprises the number of observations around the mean will be lesser.

This will lead to distribution being less peaked which is called leptokurtic.


In a football match it is said the odds of Chemsivya winning the match are 11 to 4. The probability of

Chemsivya not winning the match is closest to

a) 26.67%

b) 36.36%

c) 73.33%

Answer: A. Total events = 11+4 = 15; odds of not winning = 4/15


Raj an analyst estimates the following about BSI bank Ltd before Q1 results. The probability of EPS

decreasing in the next quarter (Q1) is 40%. Probability of EPS increasing in the following quarter (Q2) after

an increase in the previous quarter (Q1) is 70%.The probability of EPS decreasing in the following quarter





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(Q2) followed by an EPS decrease in the previous quarter (Q1) is 75%. Later, given that EPS increased in Q2

the probability of EPS having increased in Q1 also is closest to

a) 52.0%

b) 60.0%

c) 80.8%

Answer C: Probability of Q1 Decrease=40%; Q1 Increase = 60%

Probability of Q2 Increase followed by an increase = 60% * 70% = 42%

Probability of Q2 Increase followed by a decrease = 40% * 25% = 10%

Total probability of Q2 Increase = 42% + 10% = 52%

Given that Q2 there was an increase, the probability of Q1 also have increased = 42% / 52% = 80.8%

Q1 Q2 Total Probability

Increase 70% =60%*70% =42%

Increase (1-40%) = 60%

Decrease =(1-70%)= 30% =60%*30% =18%

EPS

Increase (1-75%) = 25% =40%*25% =10%

Decrease (1-40%) = 60%

Decrease = 75% =40%*75% =30%

Total probability of EPS increase in Q2 = 42%+10% = 52%. Probability of Increase followed by an increase =

42%/ 52%





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An analyst estimates that the yearly average and standard deviation of returns for Indian stock markets

have as 14% and 18.5% respectively. The probability of the stock market delivering a return in the range of

-5% and 0%, assuming the market follows normal distribution is close to (Use Z- Tables)

a) 7.24%

b) 15.22%

c) 22.46%

Answer: Z= (X-mu) / Sigma; Z value corresponding to 0% = -0.76; Z value corresponding to -5% = -1.03;

From Z table -0.76 corresponds to 22.46% and -1.03 corresponds to 15.22%. This in essence means the

probability of return being less than zero is 22.46% and probability of return being less than -5% is 15.22%.

Hence the probability of return being between -5% and 0% is 22.46% - 15.22% = 7.24%


The probability of a student sticking for more than a year in his first job is 10%. The probability of at least 2

students sticking to their job for more than one year in a sample of 8 students is closest to

a) 14.88%

b) 18.69%

c) 61.74%

Answer: Using Binomial distribution P(0) = 43.04%, P(1) = 38.2%. P(X<2)=43.04%+38.2%=81.3%. P(X>= 2) =

1- 81.3% = 18.69%


An analyst estimates that the monthly average return of a fund is 1.3% and monthly volatility of the fund is

3.7% using the data for past 24 months. The analyst makes a statement “We can say with 95% confidence

that monthly average return of this fund is greater than Zero”. The analyst is

a) Incorrect based chi-square test with degrees of freedom of 23.

b) Correct based on student-t test and the standard error of this sample is 0.76%

c) Incorrect based on student-t test and the standard error of this sample is 0.77%

Answer: A. For testing mean of a sample student’s t-test need to be used. Standard error = Sample SD/

Sqrt(n) = 3.7%/ Sqrt(24). Degrees of freedom for t-test are n-1. At 95% confidence level t-table value is

1.714. H0= Mean>0%. 1.3% - 1.741 * 0.76 = 0.01% hence H0 is accepted.


A credit analyst estimates that the probability of default within 1 year for bonds with less than 1.5X interest

coverage ratio is 35%. The analyst is tracking 45 such companies. The standard deviation of default for the

analyst’s tracking portfolio is closest to





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a) 22.75

b) 10.24

c) 3.20

This follows Bernouli’s distribution where variance will be given by n*P*(1-P); 45*35*65 = 10.24; Standard

deviation = sqrt(10.24) = 3.20


A technical analyst watching movements of two large cap indices in India, Nifty and Sensex believed that

later is more volatile than the earlier. To test this he collected data for last 25 trading sessions.

Nifty: Average: 0.9%, Standard Deviation: 7.2%

Sensex: Average: 0.85%, Standard Deviation: 4.9%

F value with Df1=24 and Df2=24 at 5% significance is 1.98

F value with ds1=24 and Df2=24 at 2.5% significance is 2.27

The analyst’s believe that the volatility of the Sensex is lesser is

a) Right at 5% significance as Ratio of SD > Critical F Value

b) Right at 2.5% significance as ratio of SD > Critical F Value

c) Not right at 5% significance as ratio of SD < Critical F Value

Answer: C. 7.2%^2 / 4.9%^2 = 2.15. The critical value at 5% is 1.98; since 1.98< 2.15 at 2.5% significance the

volatilities are different


An analyst read in a news item that Chincinnati fund reported a Sharpe ratio of 0.167 for the last year and a

treynor ratio of 0.033 for the same period. He calculated the market volatility for the period as 16%. The

coefficient of correlation of the fund with the market is closest to

a) 0.90

b) 0.81

c) 0.13

Answer: B.

In the below explanation symbols with suffix ‘p’ indicates portfolio and suffix ‘m’ indicates market.

Sharpe = (Rp – Rm) / SDp; Treynor =(Rp – Rm) / Beta;

Sharpe / Treynor = Beta/ SDp; = (Correlation * SDp * SDm) / (SD m^2 * SDp) = Correlation/ SDm;

Sharpe / Treynor = Correlation/ SDm = 0.167/0.033 = 5.06





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Correlation = 5.06 * 16% = 0.81


Below are excerpts from real Ltd’s Financial statements (all values are in mn). The company’s ‘Free cash

flow to firm’ is closest to

EBITDA : 2200

EBIT : 1925

EBT: 1800

Net Profit: 1500

Net Debt Raised: 500

Increase in Current Liabilities: 100

Increase in Current Assets: 120

Dividend paid : 200

Capital Expenditure: 600

a) Rs. 1259 mn

b) Rs. 1299 mn

c) Rs.1280 mn

Answer A: FCFF = [EBIT x (1-tax rate)] + Dep - FCInv – WCInv;

Tax rate = (EBT-NP) / EBT = 16.67%; 1925 * (1-16.67%)+275-600+100-120= Rs. 1259


Below are the details of a bond. For 100 bps change in yield the convexity adjustment that needs to be

done for the bond is closest to

Coupon %: 5%

Coupon Payment per year: 1

FV USD: 100

Maturity Years: 5

Yield: 4.50%

a) 0.12

b) 12.10

c) 24.20

Answer A: With given data find current Market price =USD 102.1935

Find price if yield drops to 3.5% = USD 106.7689

Find price if yield increases by 100 bps = USD 97.8655

Convexity = V1 + V2- 2Vo/ (2*Vo*100*(change in yield)^2)

= [106.7689+97.8655-2*102.1935] / [2*102.1935*0.01^2*100] = 0.12





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Maya Limited reported an Inventory Turnover Ratio of 0.4X. The company uses FIFO inventory valuation

method in the present inflationary environment. If the company had used LIFO inventory valuation instead

their Inventory turnover would have been

a) Higher

b) Lower

c) Same

Ans A: LIFO inventory turnover ratio would have been higher.

Inventory Turnover = COGS/ average inventory

In an inflationary environment under FIFO the older items which are cheaper will become part of COGS and

costlier items will become part of Inventory.

If we convert FIFO in to LIFO then COGS will increase and the inventory will decrease.

Let us take numbers: COGS 40, Average inventory 100. Last year LIFO reserve is 25 and current year LIFO

reserve is 30.

Inventory turnover under FIFO = 40/100 = 0.4X

Now, under LIFO

LIFO COGS = FIFO COGS + Change in LIFO Reserve; LIFO COGS = 45

LIFO inventory = FIFO inventory - LIFO Reserve; LIFO inventory = 100-30 = 70

LIFO Inventory turnover = 45/70 = 0.64X


Subjective follows LIFO inventory system for its reporting purpose in the current inflationary environment.

All else remaining the same if the company has used FIFO inventory system the cash on books would have

been

a) Higher

b) Lower

c) Same

Ans B: Lower. When it comes to cash flow the only difference between LIFO and FIFO is the tax paid. LIFO

company reports higher cost and hence ends up paying lower tax. This leads to higher cash at the end of

the year.


In May 2009 Air Chennai the airline operator opened the online advance booking for flights in November

2009. All the tickets got sold in May 2009 and the company collected Rs.125 crs in May 2009. The

passengers travelled in November 2009 however Air Chennai paid the flight lease charges only in March

2010. Air Chennai should report the revenue with respect to this advance booking in

a) May 2009





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b) November 2009

c) March 2010

Answer B: Revenue should be recognized when it is earned. Revenue is earned only one the service is

delivered which is in November 2009.


Laurence Ltd has leased an asset and currently reporting the lease as an operating lease and reported an

interest coverage ratio of 4.0x. An analyst feels that the lease is essentially capital in nature and hence

adjusted the financials accordingly for his analysis. Post the adjustment the Interest coverage ratio under

capital lease would be ------------- compared to the Interest coverage ratio under operating lease

a) Same

b) Higher

c) Lower

Ans C: Two adjustments will be made.

The operating lease rental will be removed – Increase Gross profit

i) The amount equal to principle will be amortized – There will be a net increase in EBIT because

cost of goods sold decreased but amortization increase but by an amount that is lesser than

decrease in COGS

ii) Interest payment increases. Because part of the lease payment is interest

To conclude EBIT would be higher and interest also would be higher. This difference will be equal on a

Dollar basis. Given that the ratio currently is more than 1x, the above adjustments will lead to decrease of

interest coverage ratio. If the current ratio is less than 1X, the answer does not hold good.


Laxman Ltd reported a return on equity of 27%. Net profit margin of 6% and Asset turn over ratio of 1.4X. If

the company had Equity of 550 crs what would be the company’s Average total assets

a. Rs. 1767 crs

b. Rs.183.3 crs

c. Rs.2475 crs

Ans A: This question uses dupont analysis. Financial leverage = RoE/ (NPM * 1.4) = 0.27/ (0.06 * 1.4) =3.2X.

Assets = Equity * Financial leverage = 3.2* 550 = 1767.


Natural Pharma a bio pharma company sold a new molecule about which it has researched and established

commercial feasibility to Pfizer inc . The molecule is yet to be commercially developed. Natural Pharma has





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so far spent Rs.120 crs in researching this molecule and the molecule has been sold to Rs.200 crs. What

would be the incremental profit before tax recognized by Natural Pharma during the year of sale?

a) Rs.0

b) Rs. 80 crs

c) Rs. 200 crs

Ans C: Q1 All the costs incurred during research phase has to be completely expensed (both IFRS and US

GAAP) so the Rs.120 crs is anyways expensed. The ‘incremental profit’ is because of selling the molecule is

thus Rs.200 crs.


It is a normal inflationary situation and prices are increasing. MAS ltd which uses FIFO inventory valuation

reported a Net Loss of Rs.125 crs and earnings before tax of Rs.( -125 crs). The company reported an

operating cash flow of Rs. (-75 crs). All else being the same if the company has used LIFO instead of FIFO

MAS’s Net loss and Operating cash flow would have been

Net Loss and OCF of

a) Lower and Higher

b) Same and Higher

c) Higher and Same

Answer:C. LIFO leads to higher COGS in inflationary environment. Higher COGS means higher loss. The

difference between LIFO and FIFO inventory will create difference in CFO only through tax (i.e Tax = EBIT *

Tax rate, if EBIT is lower with LIFO tax will be lower leading to higher CFO and vice versa). In this case since

company is making losses there in no tax and hence CFO under both LIFO and FIFO will be same.


Happy Inc which uses LIFO inventory valuation system reported the following

2011 Inventory – 325

2012 Inventory – 345

2011 LIFO reserve – 35

2012 LIFO reserve – 45

For the year 2012 the 2012 Happy Inc reported as sales Rs.1250 crs and Gross profit of Rs.470 crs. An

analyst makes the necessary adjustment for converting the inventory to FIFO and calculates happy Inc’s

Inventory turnover ratio. The analyst’s estimate would be closest to

a) 3.33X

b) 1.98X

c) 2.05X

Ans C:





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FIFO Inventory = LIFO inventory + LIFO Reserves

FIFO COGS = LIFO COGS – Increase in LIFO Reserves.

FIFO Inv 2012= 345+45 = 390; FIFO inv 2011 = 325+35=360;

Change in LIFO Reserves 2012 = 45-35=10

LIFO COGS 2012 = 1250-470 = 780

FIFO COGS 2012 = 780-10 = 770

Inventory Turnover = COGS/ Average inventory = 770/ Average (390, 360) = 770/375= 2.05X


Edusuper limited bought a patented learning system and recognized Rs.80 crs of intangible assets in

relation to this purpose. Edusuper should

a) Ammortize this expense every year

b) Test the impairment of the patent every year

c) Both amortize every year and test for impairment

Ans C: Patent is for specific years and this is an identifiable intangible asset. Identifiable intangible asset

with finite life should be amortized every year. This also should be checked for impairment every year.

On the other hand Intangible Assets with infinite life will ONLY be tested for impairment every year.


Hayden and Gill were discussing about effect of ESOPs on accounting statements and they made the

following statements

Hayden: Companies can get tax benefits when ESOPs are exercised which will be shown as part of

operational activities. This may artificially increase the effective tax rate of the company which an analyst

should adjust for analytic purpose.

Gill: It is an irony that while money spent on stock buyback, for issuing shares during exercise of ESOP is

considered as financing cash flow the tax benefit arising out of this is considered as operational cash flow.

This results in situation wherein more is the difference between ESOP strike price and actual stock price

more will be the operational cash flow of the company.

a) Both are wrong

b) Only Hayden is wrong

c) Only Gill is wrong

Ans B: Exercising of ESOP will happen when current market price is greater than strike price. This will lead

to loss, which will result in effecting tax rate artificially decreasing and not increasing. Other statements are

correct





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Nestle Ltd reported a net profit of Rs.9620 million for the year ending December 2011. At the start of 2011

the company had 48.2 million shares outstanding. The company issued a 1:1 bonus on 1-July-2011. The

company also had 5 million ESOPs outstanding at an exercise price of Rs.7000/share (at the start of the

year) throughout the year. Nestle’s closing share price on 31-December-2011 was Rs.4500/share and

average share price (adjusted for bonus) during the year was Rs.4300/share. Calculate the diluted EPS for

the company.

a) Rs.97.90

b) Rs.133.06

c) Rs.94.64

Ans A:

Pre-bonus shares: 48.2*12 months =578.4

Post Bonus shares: 48.2* 12 months=578.4

Weighted average shares outstanding = (578.4 + 578.4)/12 = 96.4 mn

Post bonus the ESOP will become 10 million shares (5 million adjusted for 1:1 bonus) outstanding with a

strike price of Rs.3500 (i.e 7000/2)

By treasury stock method, if 10 million options were exercised company would receive

10*3500= 35000mn. Using this company can buy shares at Rs.4300 (average price). i.e 35000/4300=8.14

mn shares. So dilutive shares added would be 10 – 8.14 =1.86 mn.

Total shares to be used for calculating diluted EPS = 96.4+1.86 = 98.26 mn.

Diluted EPS = 9620/98.26 = 97.90


Rabi Ltd reported an Total Asset turn over ratio of 1.9X and Net profit margin of 8.6% for year 2011. At the

end of 2012 Rabi used its entire net profit for 2011 to repay its debt and brought down the debt equity

ratio to 0.6X. If the sales for 2012 remained exactly same as 2011 then Rabi’s Total Asset turn over ratio for

2012 would be (no equity capital raised during the year)

a) Same as 1.9X

b) Below 1.9X

c) Above 1.9X

Ans A:

If the company uses its entire profit to repay the debt then the size of the balance sheet will remain the

same. i.e the increase in owner’s equity will be offset by decrease in Debt. The point to note here is

irrespective of Debt repayment equity will increase, a decrease in debt will be offset by decrease in cash. If

the balance sheet remains size the same as does the sales then both numerator and denominator of asset

turn over ratio will remain the same. This would lead to same asset turn over ratio.





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Let us see some numbers

Year 0 (Y0) -- Equity = 50 ; Debt = 50; total asset = 100;

Net profit in Y1 = 10;

Step 1 – Profit gets added to R&S

Y1—Equity = 60; debt = 50; TA = 110; simultaneously cash increases by 10 on Asset side (assuming

everything is cash profit)

Step 2 – Debt Repayment

Y1—Equity = 60; debt = 40; TA =100; simultaneously cash would decrease by 10 on Asset side towards debt

repayment.

Hence Total asset remains at 100.


All else remaining equal during the initial years of life of an asset, the Operating Cash flow (CFO) of a

company that follows Double declining Balance depreciation (DDB) for the asset compared to a company

that follows Straight line (SL) depreciation for the asset would be

a) CFO of DDB company = CFO of SL company

b) CFO of DDB company > CFO of SL company

c) CFO of DDB company < CFO of SL company

Ans B: CFO of DDB will be higher.

Let us see how this works. Let us assume the company does not have capex or change in working capital

requirements

For SL Company

Gross profit = 100; depreciation =25; EBT=100-25=75; Tax @33.3% =25; so Net profit = 75-25=50;

CFO = Net profit+ Non cash charges-capex-increase in working capital;

CFO= 50+25-0-0=75

For DDB company

Gross profit = 100; depreciation =35; EBT=100-35=65; Tax @33.3% =21.7; so Net profit = 65-21.7=43.3;

CFO =43.3+35 -0-0 = 78.3

The difference arises because of the tax shield on depreciation expenses. If the effective tax rate is zero

then only CFO of SL company = CFO of DDB company


Given below are particulars of Blake Ltd. Calculate the diluted EPS

• Net Profit Rs.220 million

• 10 million shares outstanding.

• Average share price is Rs.300.

• Year-end share price is Rs.330.





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i. 100,000 Convertible Debentures with Face value of 1000 and coupon of 8% p.a

ii. Each bond can be converted in to 4 shares of Blake Ltd.

iii. Tax rate 30%

a) Rs.21.69

b) Rs.20.00

c) Rs.21.92

Answer A: Conversion will increase 400,000 shares. So post conversion shares Outstanding will be 10.4 mn.

Conversion will save the coupon which is 100,000* 1000 * 8% = 8mn. However tax shield will be lost so net

increase in profit after conversion would be 8 mn * (1-30%) = 5.6 mn. Adj Net profit = 220+ 5.6 = 225.6 mn.

Adj Shares OS = 10.4 mn. Dilued EPS = Rs. 21.69


Rahul and Khan were discussing about Long lived assets and they made the following comments

Rahul: Calculating depreciation under US GAAP is bit more difficult as it requires component wise

depreciation. However when it comes to writing back of impairment loss it makes prediction of EPS bit

easier as it does not allow writing back of impairment loss recognized earlier.

Khan: The classification of ‘Investment property’ category under IFRS helps analyst to separate operational

assets from non-operational assets in many cases. However US GAAP does not have any such classification.

a) Only Rahul is correct

b) Only Khan is correct

c) Both are correct

Ans B:

Component wise depreciation is required by IFRS and not US GAAP

Writing back of impairment loss is not allowed under US GAAP. However IFRS allows writing back to the

extent of loss recognized earlier

Classification of investment property is applicable only under IFRS.


Zeal Ltd bought a machinery for Rs.200 mn. The tax base of the machine at the end of Year 3 is Rs.50 mn

and carrying value at the end of year 3 is Rs.80 mn. The tax rate is 35% till the end of year 3.At this point if

the tax rate decreases to 25% what would be the change in deferred tax

a) Deferred tax liability will increase by Rs. 3 mn

b) Deferred tax liability will decrease by Rs.3 mn

c) Deferred tax asset will increase by Rs.3 mn





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Ans B: When carrying Value >tax base it will result in deferred tax liability. Deferred tax liability@35% tax

rate would be (80-50)*35%, when tax becomes 25% DL would be (80-35)*25%

Decrease in DL = (80-50)*(35%-25%) = Rs.3 mn


Kashyap Ltd and Peter Ltd reported exactly similar financial profile and business during last financial year,

except for the fact that Kashyap Ltd used LIFO inventory and Peter Ltd used FIFO inventory in the current

inflationary environment. All else being equal the working capital turnover ratio of

a) Kashyap’s > Peter’s

b) Peter’s > Kashyap’s

c) Peter’s = Kashyap

Ans A:

Working capital turnover ratio = Sales / Working capital

Working capital = Current assets – current liabilities

When LIFO inventory is used in an inflationary scenario the cheapest items will remain in the inventory

compared to FIFO. Hence Current assets will be lower which will lead to lower working capital under LIFO.

(this will hold good even if we account for increased cash which would arise because of higher OCF in LIFO)

With sales remaining same under both LIFO and FIFO and lower Working capital under LIFO would lead to

higher Working capital turnover ratio, when LIFO is used in an inflationary environment


Tamo Ltd and MM Ltd are similar is all aspects including their financials and credit ratings. Both Tamo and

MM issued 10,000 bonds of Rs.100 FV and a coupon of 9%. The bonds will mature after 5 years. However

Tamo’s issue price was Rs.98/bond while MM’s issue price was Rs.102/bond. All else remaining equal

Tamo’s Interest coverage ratio compared to MM’s interest coverage ratio will be

a) Tamo’s ICR > MM’s ICR

b) Tamo’s ICR < MM’s ICR

c) Data Insufficient

Ans B: At a conceptual level, Yield on Premium Bond < Yield on Discount Bond.

Interest expense reported in Income statement Carrying Value * Yield.

So the interest expense on a discount bond will be higher than interest expense on a premium bond. We

know

Interest coverage ratio = EBIT/ Interest.

Given the financials are same only denominators will differ.





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So discount bond of Tamo which has higher interest expense will have lesser interest coverage ratio!.

Specific to our example TAMO’s bond will attract an YTM at issue of 10.5% and MM’s bond an YTM at issue

of 9.5%. For first year Tamo’s bonds will have an interest expense of 98*10.5%=10.32. MM’s bond will have

interest expense of 102*9.5% = 9.7. So ICR of Tamo< ICR of MM. Also note as the year’s pass by TAMO’s

carrying value of bond will increase and hence its interest expense will increase. On the contrary MM’s

carrying will be decrease and hence MM’s interest expense will decrease. So Tamo’s ICR< MM’s ICR for the

entire life (all else remaining equal) .

This explanation holds for straight line amortization of bond/premium also


F-Kart an online retailer sells Merchandise through their website. In their business model once they receive

the order online they pass on the order information to merchandise manufacturers who directly ships the

material to the buyer. F-kart will receive the cash through their website from the buyer, cut their margin

and pass on the rest to the manufacturer. Last year F-Kart sold $21 mn worth of merchandise out of which

$ 16.6 mn was paid to the manufacturers. F-Kart also spent $1.2 mn towards their operating expenses.

They do not have any loan and have an effective tax rate of 35%. The Net profit margin of F-Kart is closest

to

a) 9.90%

b) 15.24%

c) 47.27%

Answer C: One of the conditions for Gross reporting is having inventory risk. In this case F-Kart does not

have any inventory risk. Hence F-Kart should follow Net reporting, in which case revenue is 21-16.6 = 4.4;

deducting Op expenses levees EBT of 3.2; 35% tax is paid which leaves net profit of 2.08. Net profit margin

is 2.08/ 4.4 = 47.27%


Lavish Ltd reported a total share holder equity of $250,000 during start of the year. During the year the

company reported a net profit of $12,500 and declared a dividend of $2,500. The company also witnessed a

loss of $250 in its investments which were classified as ‘Held for Trading’. Assuming there are no other

comprehensive income items during the year, the ending share holder equity of Lavish Ltd would be close

to

a) 259,750

b) 260,000

c) 260,250

Answer B: The loss from ‘held for trading’ securities are already included in Net profit, so no additional

adjustments required to Share holder equity; Ending share holder equity = 250,000+12500-2500 = 260,000





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Bellweather Ltd issued $100 face value bonds at $98 at the beginning of FY1. This bond which has 5 years

tenure pays annual coupon of 5% p.a. The total money raised by the company through this issue is $

1,960,000. If the company uses effective yield method for amortizing bond discount then the interest

expense (related to this bond only) that would be reported by the company in FY2 would be closest to

a) $100,000

b) $109,362

c) $107,567

Answer C: The yields on the bond is 5.47%. The company issued 20,000 bonds (1960000/98). FY 1 the

company would have reported interest expense per bond of 98*5.47%=5.36. So, 0.36 will be amortized

from bond discount at the beginning of FY 2 and the bond would be carried at 98.36. FY2 interest expense

is 98.36*5.47%= $5.38 per bond. Total interest expense = 5.38% * 20000 = 107,567


Below are selected items from Corebiz Ltd. The Cash flow from Financing of the company according to US

GAAP is closest to (All values are in mn)

Net profit: $2500

Increase in Working Capital: $375

Secured Loan borrowed: $450

Unsecured loan repaid: $ 200

New machine bought: $ 300

Old machine sold (scrap): $ 50

Dividends Paid: $650

a) $ 1300

b) $ 250

c) $ (-400)

Answer C: In general Long term liabilities are Cash flow from financing activities. Secured loan borrowed –

Loan repaid – Dividends paid are the liability side items. 450-200-650= (-400)


Below are excerpts from a financial statement. The free cash flow to firm of this company would be closest

to

EBITDA: 1650

EBIT: 1375





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EBT: 1250

Net Profit: 875

Inc in Acc. Receivable: 150

Inc. In Acc Payable: 170

Loan borrowed: 200

Loan Repaid: 150

Dividends Paid: 225

Capex: 450

a) 857.5

b) 257.5

c) 807.5

Answer C: FCFF = EBIT * (1-t)- Inc in WC – Capex + Depreciation and Amortization;

Dep = EBITDA – EBIT = 275; Int = EBIT – EBT =125; Tax = PAT – EBT =375; tax rate = 375/ EBT = 30%

FCFF = 962.5 – (-20) – 450 +275 = 807.5


Fastcars Ltd reported a Return on Equity of 17.9% last year. The company’s Return on Total Assets for the

period was 12.12%. Assuming that the company does not have any non interest bearing debt, Fastcar’s

Debt to Equity Ratio is closet to

a) 47.8%

b) 67.68%

c) 148.8%

Answer A: RoE = NP/ Equity; RoA = NP/ Total Assets; RoE/ RoA = Assets/ Equity (which is financial

Leverage); FL = 17.9%/ 12.12%= 1.48%; Equity/ Assets = 67.68% = Equity/ (equity+Debt)= 67.68%; Debt

Asset = 1- 67.68% = 32.32%; this implies debt is 32.32% of assets and equity is 67.68% of assets. So, D/E =

32.32%/67.68% = 47.8%.


James and Bailey were discussing about Inventory reporting. They made the following statements. How is

correct?

James: All else remaining the same, the inventory turnover ratio of a company that uses LIFO will be greater

than the company that uses FIFO. However when it comes to working capital turn over ratio both FIFO and

LIFO company will have same ratio





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Bailey: If the taxes are zero then cash flow from operations of FIFO and LIFO company will be the same.

However net profit margin for a LIFO company will be lower than FIFO company ir-respective of taxes.

a) Both of them are wrong

b) Both of them are right

c) Only Bailey is right

Answer C: James Statement 1: We know that LIFO company’s inventory will be lower and COGS will be

higher. This makes Statement 1 correct.

James Statement 2: WC = CA – CL; CL will not change. CA = Cash + inventory + other CA. LIFO co’s cash will

be higher (CFO is higher) and inventory will be lower. However they will not compensate each other. The

higher cash will be to the extent of tax saving i.e (LIFO COGS – FIFO COGS) * tax rate. So in essence CA will

be lower for LIFO co. this would makes net WC lower. WC Turnover ratio = Sales / Net WC. So, LIFO co will

have higher WC turnover ratio

Bailey Statement 1: Is right.

Bailey Statement 2: Is right. As COGS for LIFO is higher, the EBIT, EBT and Pat will be lower resulting in

lower Net profit margin.


Agassi and Sampras were discussing about long lived assets and made the following statements. Who is

correct?

Agassi: The US GAAP does not allow capitalizing intangible assets if they are created internally, except for

software developed for internal use. If the tangible asset is received in exchange for another asset then the

asset received should be capitalized ONLY at its fair value

Sampras: Long lived assets that are ‘Held for sale’ need to be checked for impairment at the time of

reclassification. Post this if the fair value of assets increases then both US GAAP and IFRS allows recognizing

gain equal to Fair Value – Carrying value.

a) Both are correct

b) Both are wrong

c) Only Sampras ins correct

Answer B:

Aggasi S1: Is correct

Aggasi S2: Is wrong. The asset exchange can be capitalized ta Fair value of the asset received or FV of asset

given up or Book value of asset given up

Sampras S1: Is correct





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Sampras S2: HFS assets gain are allowed only to the extent of loss recognized earlier. ‘Any’ amount of gain

cant be recognized.


Below are the excerpts from Kuko Ltd. The analyst does an analysis of the statement and finds that the

deferred tax asset is because of company’s last year loss and he also believes that company is not expected

make profits for the foreseeable future to setoff this carry forward. He also notices that there is a deferred

tax liability which arose because difference in depreciation rate of a machinery. The machine which has a

life of 20 years has completed just 1 year of life. For analytical purpose the Financial leverage that the

analyst should calculate is closest to

Share holder equity: 3500

Borrowed Liabilities: 1500

Deferred tax Liabilities: 400

Total Liabilities: 5400

Net Fixed Assets: 4600

Current Assets: 200

Deferred tax assets: 600

Total Assets: 5400

a) 1.54X

b) 1.45X

c) 1.38X

Answer B: Since the company is loss making DTA cant be recovered and DTL need not be paid back (tax is

anyways Zero). So reduce DTA and reduce Share holder equity by the same amount. Reduce DTL and

Increase Share holder equity(SHE) by same amount.

DTL Adjustment: SHE = 3500+400 = 3900; DTL =0; total Equities+ tot Liabilities = 5400

DTA adjustment: SHE = 3900-600=3300, DTA=0; Tot Equities + Total Liabilities = 4800

Fin leverage = 4800/ 3300 = 1.45X


During the initial years of bond issue which of the following statement(s) would be true for a company that

uses effective yield method of amortization for carrying the bonds. All else remaining the same,

i) Debt Equity ratio of the company that issues premium Bond< D/E of the company that issues

discount bond





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ii) Financial Leverage of the company that issues premium bond > FL of the the company that

issues discount bond

iii) Operating cash flow of the company that issues premium bond < OCF of company that issues

discount bond

a) All of the above

b) I & II only

c) II & III Only

Answer C: I is wrong: At inception $ 100 par bond issued at premium will be recorded at more than $ 100,

let us say $105. This will increase the liability of the company, while equity remains the same. As a result

D/E of Premium Bond Company will be higher

II is Correct: As an extension of previous statement D+E will increase for premium bond while equities

remain same for the premium bond. As a result FL will be higher for premium bond. In simple terms debt

will be higher hence FL will be higher

III is correct: The operating cash flow of both Premium bond and Discount bond will be same if the taxes

are absent (because even though interest expense are different, the actual outflow is only coupon which is

same for both bonds). However remember discount bond has to pay higher interest under effective yield

method, these results in lower EBT and lower tax. As a result the discount bond company will have higher

OCF.


Dum Ltd sold an asset for Rs.500 crs and reported a gain of Rs.50 crs in the income statement as ‘Gain from

the disposal of asset’. The carrying value of this asset before sale is

a) 500 crs

b) 450 crs

c) 550 crs

Ans B:Gain from sale of disposal of asset = Sale value – Carrying value

50 = 500-CV

CV=450


Which of the below statement is NOT correct about Zero coupon bond

a. Zero coupon bonds will never trade above par value

b. Price of Zero coupon bonds are less sensitive to change in interest rates

c. Zero coupon bonds will be issued at a deep discount to the face value

Ans B: For bonds with similar maturity the 'Duration' of Zero coupon bond will be higher than coupon

paying bond. Hence the price of Zero coupon bond is more sensitive to change in interest rates.





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A 5 year semi annual coupon paying bond with a face value of $100 is currently trading at $97.54. The bond

pays a coupon of 6.5% p.a. The convexity of this bond is closest to

a) 0.1058

b) 10.58

c) 4.19


A 15 year Zero coupon bon is currently trading at 68-24. The bond equivalent yield of this issue is closest to

a) 2.498%

b) 2.529%

c) 2.514%

Answer C: Price of the bond is 68.75. Annualised yield of the bond = [100/68.75] ^ (1/15)=2.529%. Bond

equivalent yield is semi-annual yield so,{ [(1+2.529%) ^0.5] *2 } -1 = 2.514.


If the interest rate volatility increases, all else remaining the same the price of a putable bond will

a) Increase

b) Decrease

c) Remain the same

Ans A: Price of a Callable bond = Price of an ordinary Bond – Call option Premium

Price of a putable bond = Price of an ordinary Bond + Put option Premium

An option premium will be determined by Spot price, Strike price, Volatility of the underlying, Time for

expiry and Risk free interest rate. An increase in the last 3 parameters will lead to increase of option

premiums of both call option and put option.

So, when volatility of interest rate (the underlying) increases the put option premium will increase. As per

the above formula, when put option premium increases the price of the putable bond will increase.


The price yield relationship curve of the bond for prices above the callable price

a) Will have higher convexity compared to an option free bond

b) Will have negative convexity

c) Will have similar convexity as an option free bond





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Ans B: Convexity is the second derivative of price change for a unit change in yield. For a large change in

yields one need to do convexity adjustment to get a better approximation of price change of the bond.

For a callable bond when the market price are above the callable price the bond faces the risk of being

called and hence for further drop in yield the bond price will not make big moves. At this point the

convexity of the bond will turn negative.


The current treasury spot rates for various maturities are given below

0.5 Years – 3%

1.0 years – 3.1%

1.5 years -3.25%

2.0 years – 3.3%

The arbitrage free price of a semi annual coupon paying treasury bond with coupon rate of 7% p.a, face

value of USD 100 and exactly 1.5 years left to maturity will be closest to.

a) USD 105.4470

b) USD 105.4563

c) USD 105.4593

Ans B: In an arbitrage valuation all coupons need to be discounted by respective treasury spot rates.

The discount rate should be converted to semi annual rates i.e for 0.5 year it would be 3.0%/2 and so on.

Arb free price = 3/(1+1.5%)^1 + 3/(1+1.55%)^2+ 103/(1+1.625%)^3=USD 105.4563


A bond which pays a coupon of 5.5% pa is trading at a price of USD 102. The bond pays coupon

semiannually, has a face value of USD 100 and has 3 years left for maturity. If the Macaulay duration of this

bond is 2.80 years then for a 25 bps increase in yield the price of the bond would

a) Decrease to USD 101.27

b) Decrease to USD 101.30

c) Decrease to USD 101.22

Ans B: Duration – In general indicates price sensitivity of the bond’s price to change in yields. In specific

Macaulay Duration: Indicates the time taken to get the invested capital back. Faster you get better it is. So,

lesser the yield lesser the time required to get your money back and vice versa. However this still does not

provide the exact quantum of risk w.r.t yield change.

Macaulay duration will be given by:( t1*PVCF1+t2*PVCF2+…….+ tn * PVCFn)/ (k*Price of the bond)





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Where t1, t2 etc represent each cash flow i.e either coupon or principle repayment, PVCFn – indicates

Present value of cash flow n and k indicates number of coupon per year.

Modified duration: Modified duration provides the likely percentage change in price of a bond for a

percentage change in yield. In other words a modified duration of 4.2 would indicated for every 100 bps

change in yield price would approximately change by 4.2% (note the word approximately as for large

changes this relationship will not hold good, effect of convexity will come in to play)

Modified duration will be given by = Macaulay duration/(1+[yield/k])

For our question we need Modified duration to find the price change. For which we need to find the yield

of the bond. The yield of this bond can be found as 4.78%.

Modified duration = 2.8/(1+[4.78%/2]) = 2.73. This indicates for every 100 bps change in yield price will

change by 2.73%.

So for 25 bps change the price change will be approximately 2.73/4 = 0.68.

The price of 102 will decrease by 0.68% i.e 102*0.68= 0.70

Price of the bond after increase in yield will be equal to 102 - 0.69 = USD 101.3


Adam purchased a 5 years semiannual floater bond at a price of $101.23. The face value of the bond is

$100 and the coupon is LIBOR+40 bps. The spread for life of this bond is closest to

A) 15.21 bps

B) 15.40 bps

C) 63.82 bps

Ans A: The spread for life essentially indicates the average spread that an investor will receive above the

reference rate if he holds the bond till maturity. i.e

Let us say currently a bond with 5 years left to maturity which pays a coupon of LIBOR+20 bps is trading at a

discount of 100 bps to the par rate.

Now this 100 bps spread will be spread over 5 years, indicating 20 bps/year. The standard spread over

LIBOR is 20 bps/year. So a total spread of 20+20 =40 bps. However please note this spread is correct only if

you buy the bond at par value, to adjust the spread for your actual purchasing price multiply the above

spread for life by [ face vale / Purchase price]

This does not take Time value in to account which is one of the disadvantage of this measure.

The spread for life can be calculated as (Note the spread will be always measured in basis points)

SFL = { [100 * (100-Price)]/ Life of the bond + Spread above reference rate} * 100/ Price of bond





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{[100*(100-101.23) / 5] + 40} * 100/ 101.23}

= (-24.6+40)* 100/101.23 = 15.21 bps


A Zero coupon bond with exactly four years left for maturity is trading at USD 77.52. The face value of this

bond is USD 100. The Yield to Maturity of this bond is closest to

a) 6.67%

b) 6.57%

c) 6.47%

Ans C: While many of us felt that this is an easy and straight forward question, some of us missed the

important point.

“In the absence of coupon all bonds are considered as semi annual coupon paying bonds.(refer page 457

book 5). “

For our question this would imply

100/(1+r)^8 = 77.52. And the yield on bond is r*2. I.e 100 discounted by semiannual yield for eight period

(8 semi annual coupon paying periods). Solving for ‘r’ we would could 3.234% which is semiannual yield.

The annual yield would be 3.234*2 = 6.47%


A 5 year annual coupon paying bond is trading at a price of USD 102.19. The duration of the bond is 4.35

and convexity of the bond is 0.24. For a 200 bps increase in yield the price of the bond will approximately

move to

a) USD 93.79

b) USD 93.30

c) USD 92.80

Ans B: The modified duration gives price change of a bond only for a small movement in yield. For larger

changes one need to do convexity adjustment. So, for large movement in yields price changes should be

estimated by

Duration * Change in yield in percentage + 0.5 * Convexity * (change in yield )^2

-4.35*.02 + 0.5*0.24 *(.02)^2 = -8.7%

The price of USD 102.19 will decrease by 8.7% i.e 102.19*(1-8.7%) = 93.30


Eva purchased Treasury Inflation protected securities (TIPS) on 1-January-2011. The annualized inflation at

that time is 2.4% and after six months the same has increased to 2.8%. The TIPS has a face value of





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$100,000 and coupon of 3.5% p.a paid semiannually. The coupon that will be received by Eva FOR the 2nd

half (2nd half ONLY) of the year will be closest to

a. USD 1,750.0

b. USD 1,842.2

c. USD 1,795.8

Ans C: The principle for the first half would be 100,000 *(1+1.2%) = 101,200 (1.2% is.half of full year

inflation of 2.4%)

Principle for the 2nd half would be 101,200*(1+1.4%)=102.616.8

Interest = 102,616.8 * 3.5%/2 = 1,795.8


John and Sidebottom were discussing about index weighting methodologies

John: The major disadvantage of equal weighted index is the weight of the stock in the index decreases

during stock split. The market cap weighted suffers from a disadvantage of being unduly influence by big

companies.

Sidebottom: It is easy for an Exchange Traded Fund (ETF) passively tracking a price index to outperform as

ETFs receive dividends. The Market cap weighted index need to be re balanced frequently as market cap

change every day.

a) Both are Wrong

b) John is right

c) Sidebottom is right

Ans A: The equal weight index will not be affected by stock split. It suffers from the disadvantage of

requirement for frequent rebalancing. Market cap weighted index adjusts for weighting automatically it

need not be rebalanced. Other statements are correct


Which of the following auctions will get each bidder to reveal their correct reservation price

a) First Price Sealed Bid Auction

b) Second Price Sealed Bid Auction

c) Ascending Price Auction

Answer B. In a first price sealed bid, the top bidder only has to bid slightly higher that the second highest

bidder. Thus he/she will not reveal the true reservation price. The second price sealed bid gives the bid to

the top bidder, but the payment made is that of what the second highest bid was. This ensures that each

person bids to their maximum capability.





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Which of the following is Most likely correct?

a) Under imperfect competition, the marginal revenue curve is lower than average revenue curve

b) Under imperfect competition, the marginal revenue curve is higher than average revenue curve

c) Under imperfect competition, the marginal revenue curve is the same as the average revenue

curve

Answer A. In imperfect competition, you can only sell more by cutting prices. Thus MR < AR


In the case of an inflationary gap, an investor would want to

a) Increase investments in defensives

b) Decrease investments in Commodities

c) Decrease investments in long maturity fixed income securities

Answer C. As interest rates are expected to rise





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answer b